Question

Price a put option with a one-step binomial tree. Suppose So=50, X=40, 1+r=1.06. The u factor is 1.4 and the d factor is 0.6. Show the steps

Answer 1

S0 = 50

X=40

1+r = 1.06

u = 1.4

d = 0.6

up price(Su) = 50*1.4 = 70

down price(Sd) = 50*0.6 = 30

Risk neutral up price probability P(u) = (1.06-0.6)/(1.4-0.6) = 0.575

Risk neutral up price probability P(d) = 1-0.575 = 0.425

Put option payoff for up price (Vu) = Max(40-70,0) = 0

Put option payoff for down price(Vd) = Max(40-30,0) = 10

Price of Put option(P):